Providing useful insights and making the complex world of energy more accessible, from an experienced industry professional. A service of GSW Strategy Group, LLC.

Tuesday, August 31, 2004

Where Will Our Gasoline Come From?
An article in today’s Wall St. Journal highlights an important issue that has received little attention, even in this year of unusually high crude oil and gasoline prices. As the article’s title suggests, “US Relies on Europe For Gasoline”. In additional to all the crude oil this country imports, we also bought over two million barrels per day of petroleum products from foreign refiners last year, with a quarter of that consisting of finished gasoline, and a similar fraction requiring further processing or blending. This dependence will only grow in the years ahead, if US gasoline demand continues to ratchet up.

There are good reasons for our loss of gasoline self-sufficiency. First, as domestic crude oil supplies dry up, US refineries lose some of their competitive advantage against imports. More importantly, the domestic refining industry has been saddled with two decades of high investment to meet increasingly strict environmental regulations, both on the properties of the fuel and on refinery emissions.

Although necessary to stay in business, these investments have yielded very poor financial returns for oil companies, since consumers have not seen the changes as something for which they were willing to paying more. Nor have the government’s regulations provided for any profit-recovery on mandated investment, leaving that to the market. Other regulations make building new refineries in this country virtually unthinkable. The net result has been refinery closures and little investment in new capacity to keep up with demand.

As the Journal points out, this problem has been manageable so far, because Europe is in the midst of a sea-change from gasoline to diesel for its new cars, nudged along by tax and emissions policies that favor the latter. For European refiners, the opportunity to export to the US has provided a dual benefit; not only are they able to sell a high-margin product for which demand in Europe is falling, but they can forego the expensive refinery retooling that would otherwise be required to convert more oil to diesel and less to gasoline. But as the article suggests, there are strong indications that foreign suppliers, especially those in Latin America, are not enthusiastic to invest in refinery upgrades to meet more stringent US gasoline specifications, when other export markets--such as a rapidly growing China--may be just as attractive without additonal investment.

What is the likely outcome of this situation? Clearly US gasoline prices, particularly in regions such as the East Coast that are highly dependent on imports, must rise relative to crude oil. And these higher margins must persist long enough to offer US or foreign refiners the prospect of attractive returns from investment in new capacity, which will take further years to build. So even if crude oil returns to $20 or $25 per barrel, we may not see gasoline prices as low as those of 2001 and early 2002 for a long time to come.

Monday, August 30, 2004

Safety vs. Security
Sunday's New York Times carried an article about John Young, the ex-architect who has dedicated himself to identifying our country's vulnerable infrastructure. His website, for which I decline to provide a link, amounts to a one-stop-shopping site for information about natural gas pipelines and pump stations, nuclear power plants, and even the security preparations for the Republican convention in New York. Mr. Young thus personifies a central dilemma of our time: how do you balance the public's right to know about things that impinge on their safety and security with the need to hide them from malefactors who would seek to destroy them?

When I first heard of Mr. Young several months ago, I thought he was providing a useful service by highlighting security deficiencies that needed to be addressed. On further reflection, and particularly in light of his zeal at exposing surveillance cameras and other security systems, I have to say that he goes too far. It is one thing to give people the information they need in order to avoid damaging pipelines in the course of construction projects, but it is quite another to broadcast every conceivable vulnerability, along with the preparations by public agencies to counter them. This irresponsibly increases, rather than lowers, our risk.

How might this balance better be struck? One way might be to create a secure intranet for contractors, providing them with access only to the local infrastructure maps they might need in their work. While such a system might still be subject to hacking or subversion, it would at least not do the terrorists' work for them.

Like many people, I'm uncomfortable about any attempt to restrain free speech, even in wartime, since once restrained it may be hard to retrieve later. But there is also a time-honored principle that free speech does not include the right to shout "fire" in a crowded theater, and Mr. Young seems to be doing that as loudly as he can. I suppose its a kind of tribute to our free society that his website is still up and running; let's just hope it's not a fatal tribute.

Friday, August 27, 2004

One Step at a Time
If renewable electricity is going to become a meaningful energy source in this country, it will have to do so by providing viable alternatives to conventional power projects on an industrial scale, not just "one roof at a time." That means that large customers and utilities will have to eschew traditional, reliable choices and take a chance on something greener. As a former L.A. resident, the cancellation by the city's Department of Water and Power of their stake in a major coal plant expansion in Utah caught my eye. Anyone who doesn't believe Mayor Hahn is taking a big risk with this hasn't been paying attention to California politics, with the recall of Governor Davis at least party attributable to his inept management of the state's electricity crisis.

Now, it's fine and good to say that the city will find greener alternatives to the foregone coal project, but time will tell what that really means, since there were no specifics provided. Do they intend to spend the saved $200 million on wind and solar projects, or, when the city's appetite for power grows again, will they just build or buy into more gas-fired turbines, exacerbating the need for new sources of natural gas? In any case, the DWP is about as large as municipal utilities get, and this decision should be seen as an important milestone and potential golden opportunity for developers of renewable electricity.

Thursday, August 26, 2004

Future Oil Prices
Continuing on from yesterday's theme on oil prices and last week's comments on market backwardation, I see that the Economist (subscription required) has joined the growing consensus that oil prices are likely to remain high for some time. Their best argument comes in the form of a chart comparing the recent history of the "prompt" NYMEX WTI contract (for delivery in the next month) with that of the contracts for delivery 24 months later. It shows clearly that, despite big moves in the prompt prices, the price for two years out held steady in the mid-$20 range until the beginning of this year. Subsequently, something has convinced the market that we aren't on the verge of another slide toward "normal" prices.

The Economist article lists many reasons why high oil prices might not be temporary--including a few dubious items such as Asian speculation in oil futures as a play against the dollar. (I'm a simple type who believes that when traders want to bet against a currency, they have much better ways to do it than fooling around with a commodity that is influenced by practically everything on the planet.) If they are right, it is important for more than the obvious reasons; the level of oil prices three to five years from now is also a key signal about the sustainability of the industry.

Barring a global recession or a major slowdown in Asia, lower prices later this decade would indicate that conventional oil production can continue to expand to meet growing global demand, perhaps with a bit of help from oil sands and gas-to-liquids, but without reliance on more exotic alternatives. Prices would only fall back into the normal range if the events of the past few years have not pushed us into an entirely new regime of scarcity and constraint, or broken the industry's ability to respond to shifts in demand.

So when the longer-term futures prices join the spot-price party and backwardation shrinks, I think we should pay attention. While the futures markets don't predict the future, they provide useful insights into current thinking on it. At the moment, the market expects that prices will stay high beyond the typical response cycle the industry has exhibited in the past. That suggests the international oil majors should not only be redoubling their efforts to invest in the relatively few truly material resource opportunities out there (e.g. Russia and the Middle East), but they should also seriously reconsider some aspects of the last decade's main strategy of ruthless cost-cutting. Perhaps those "marginal" fields they've been busily divesting are not quite so marginal, and further consolidation--which reduces the industry's aggregate capital budget--might not be in the majors' or anyone else's best interest.

Today's Wall Street Journal raises this issue of oil industry underinvestment on their front page. Wouldn't it be ironic if the thing that finally drove the world away from oil and towards alternatives weren't climate change or OPEC, but the unwillingness of the oil industry to invest enough money in its core business to keep up with demand? That would have been unthinkable to the generation of oil executives who built the companies that are today's market leaders.

Wednesday, August 25, 2004

Those Hedge Funds Are At It Again!
Along with the routinely enumerated causes for the sharp escalation of oil prices in the last year, the role played by hedge funds is coming under increasing scrutiny and criticism. According to the Financial Times, the Japanese government is calling for "international discussions" on this aspect of high oil prices, though it isn't clear exactly what that means or what it might accomplish. Despite this, and in the face of the obviously serious potential consequences for the economy of sustained high oil prices, I would suggest that the concerns about hedge fund activity are overblown, at least for now.

Many of my readers have access to better statistics of hedge fund open interest on the New York Mercantile Exchange and other international oil commodity markets than I do, so I'll confine my comments to the issues, not the numbers. It does appear that hedge funds have taken a strong interest in oil futures and options, particularly as other markets have slowed. It also appears that their analytical tools drive them to increase their open positions in oil as prices go higher, adding to both the overall level of the market and to volatility, the main measure of market variability. In the short run, this creates a sort of self-fulfilling prophesy: previous futures positions appreciate as prices rise, and the value of long options grows with increasing market volatility.

But there are several ways in which the market for physical oil is buffered from these gyrations. First, although the daily trading volumes for the NYMEX West Texas Intermediate Crude (WTI) contract and the London Brent Crude futures contract are enormous relative to the actual volumes of these two grades of oil, they are not as representative of the market as a whole as some might think. While many contracts for physical crude oil are pegged to WTI or Brent, a great deal of the world's oil is too dissimilar from these light, sweet grades to be traded solely based on the futures markets. Nor is all of the world's crude actually delivered to the physical settlement locations of these futures contracts, such as the US Gulf Coast.

As a result of these factors, oil of substantially different quality, or for delivery to other locations, usually trades on the basis of a "differential" to WTI or Brent, that is, with an agreed amount added to or subtracted from the quoted daily or monthly price for the "marker" grade. For example, a cargo of heavy, high-sulfur oil delivered to the US West Coast might trade at $5.00 per barrel below WTI.

When the price of the marker crude becomes distorted by local conditions, such as unusually high or low inventories of oil in the US Midcontinent, or by excessive speculation, the differentials for the physical delivery of other grades--always in flux, anyway--will widen or shrink to take this into account to some degree. Imagine, for instance, that speculators have driven WTI up by $2.00 per barrel at the same time that increasing physical invetories of oil would suggest a drop of $2.00 might be more appropriate. The discount for that notional West Coast heavy sour cargo would probably widen from $5.00 per barrel to $6.00 or more, reflecting lower demand for it elsewhere due to higher inventories.

In addition to such cargo-specific factors, a large quantity of oil is traded on long-term contracts at prices that are not directly influenced by the futures markets. The combination of these factors means that the cost of much of the oil that is delivered to refiners around the world is at least partially protected from speculative swings in the price of the futures markets.

There's a cautionary note here for hedge funds and their investors, too. As with other markets, oil markets that get too far out of line with the underlying realities of the commodity have a tendency to correct with a vengeance. The hedge funds would not be the first to try to "corner the market" in oil, though they might be the deepest pockets to try it. The history of the industry is littered with commodity traders who built up a fabulous position but got their heads handed to them when the market finally corrected. Perhaps the funds are too sophisticated to get caught this way, but I wouldn't bet on it, which is exactly what they seem to be doing.

Tuesday, August 24, 2004

Monday, August 23, 2004

Energy Autarky
In the course of catching up on last week's energy articles, I found this excellent discussion of the future US natural gas situation by Neela Bannerjee in last Friday's N.Y. Times. In particular, I found its treatment of LNG rather more balanced than some of the breathless articles that both the Times and Wall Street Journal have run over the last several months. In any case, the concerns it raises about potential future US dependence on unstable foreign suppliers of natural gas--along the lines of our current dependence on certain oil exporters--are worth some thought.

While I suggest that Ms. Bannerjee gives too little credence to the potential to increase domestic gas supplies (if we include Alaska and northern Canada in that definition), she correctly identifies the key challenge of investing sufficient capital to create an international gas infrastructure that can deliver enough gas to keep up with our needs. And once built, this expensive infrastructure of gas wells, liquefaction plants, and tanker loading facilities is indeed hostage to the good intentions of its hosts, whether they be Australian or Libyan.

Still, although I have my own reservations about relying on LNG imports to plug the current gap in North American gas supplies, I am a lot less worried about these particular issues. The international gas industry is at a much earlier stage in its development than the oil industry. An enormous amount of gas remains to be discovered as non-associated gas, or gas that is not produced in conjunction with oil. This is an important distinction, because much of the gas that is currently being produced was found by accident while seeking oil. Until the development of practical large-scale LNG systems in the 1960s and 70s, there was little incentive for energy companies to look for non-associated gas outside North America or Russia.

The implication of this is that as this market develops, it is quite possible that the current dominance of Russian and Middle Eastern gas reserves could be balanced by the discovery of significant reserves in a number of other countries. This is especially true if some of the more extreme theories about the geological origin of natural gas turn out to be correct.

Fundamentally, the concerns raised in the Times boil down to the same debate about energy independence that has been raging on and off for the last 30 years. It hinges on whether realistic alternatives to fossil fuels can be developed on a large enough scale to power our economy and applies equally to gas as to oil. In some respects, the situation is even worse for gas, since for the last two decades it has grown not just in its own right, but as the primary economically and environmentally attractive alternative to oil.

Barring the kind of wholesale development of nuclear power suggested in this satiric piece in the Sunday NY Times, I'm skeptical that wind or terrestrial solar power can be scaled up sufficiently to prevent us from burning through much of North America's natural gas endowment and becoming dependent on imported gas, even if it is used to provide the primary energy for a future hydrogen-based economy. But in a fully-globalized world with less conflict than today's, that wouldn't be the worst outcome imaginable.

Friday, August 20, 2004

A Whole New Perspective on Life
Although I've mentioned a number of books in the course of my blogging, this is the first time I've felt compelled to review one here. The book in question might at first seem slightly off-topic, but I believe that anyone contemplating the future of the global energy industry needs to consider the ideas it contains. "The Pentagon's New Map," by Thomas Barnett, creates a coherent, comprehensive model of the world in which we now live, and in which we are likely to find ourselves for some time.

Barnett's worldview is the equivalent of a Grand Unified Theory for geopolitics in the 21st century, and he achieves this by looking ahead at least as much as he looks back. He takes into account the effects of globalization, regional demographics, energy and capital flows, jihadist movements, the War on Terror, the Iraq War, and almost everything else, with the possible exception of environmentalism, and distills them into a map and a set of dynamics and strategies that explain where we are heading. His concept of the "Core" (the countries in which globalization works) and the "non-integrating Gap" (those countries that are poorly connected and whose leaders may want them to stay that way) is brilliant in its simplicity.

Even better, Dr. Barnett lays out a positive scenario for the future that doesn't require pretending that the last several years never happened. As a professional scenario planner, I think that's a big deal. Ever since 9/11, I've really struggled to see a happier future we can actually reach from where we are. Barnett presents realistic, if difficult pathways toward a better world, as Pollyannish as that may sound.

I won't say that this book will change the life of everyone who reads it, though it has certainly shifted and uplifted my own outlook. While much of it deals with the military, it is by no means exclusively a military book. If, like me, you feel that our leaders have done a poor job of explaining our course to us and to the world, then you should find this book of particular interest. Highly recommended.

Thursday, August 19, 2004

Yesterday’s Wall Street Journal carried a guest editorial by Riad Ajami, proposing that the time was right for grand alliances between the state oil companies of the OPEC countries, which own the bulk of the world’s crude oil reserves, and the Supermajors of the international energy industry, which have access to the world’s most important downstream markets and much of the infrastructure linking the two. He suggested a linkup between ExxonMobil and Saudi Aramco, as an example. This is not exactly a new idea. However, it suffers from a fatal flaw: alliances work best when the interests of the parties are well-aligned, and the interests of the majors and OPEC may be contrary, at least in the short term.

Oil producers worry most about their ability to access downstream markets when oil is seen as abundant, and prices are soft. In such a buyers’ market, refiners can be choosy and drive a hard bargain with suppliers, who need to dispose of their production somewhere, or see it shut in. In contrast, refiners and marketers worry most about access to oil when markets are tight and even lower quality oil—heavy or high in sulfur—commands premium prices. Then, they risk having their expensive facilities underutilized, at a point in the cycle at which maximum throughput and efficiency are key. But at that point suppliers have a host of buyers competing for their output. Thus, the appetite for producers to enter into this kind of arrangement peaks precisely when that of the refiner/marketers hits its nadir, and vice versa.

Another problem relates to the main engine of earnings for the international majors. Except in rare years, they earn the lion’s share of their profits from discovering and exploiting oil and gas reservoirs. They do best when they can capture part of the economic rent associated with the resource, and that implies the need to own it, or at least have attractive, long-term access to it. The refining and marketing parts of these companies have typically been regarded as either an economic hedge or a legacy means of disposing of crude, or in industry parlance, “making it go away.” So in their most important line of business, the majors act as customers, service providers, and even competitors to the state oil companies. This is not exactly complementary, in the way you’d want for a natural alliance.

There’s also some history here. The last time this idea was tried was in the late 1980s, when Texaco formed a downstream alliance with Saudi Aramco for its US refining and marketing assets east of the Mississippi River. The stated rationale was exactly as described by Mr. Ajami. An additional alliance and a merger later, Shell now sits in Texaco’s chair in this alliance, called Motiva Enterprises. Without speaking out of school, it should be instructive that in the nearly 20 years since this alliance was formed, the industry hasn’t rushed to copy it.

As I’ve suggested in previous blogs, I believe the real opportunity here is not matching resources to downstream markets, but rather matching the majors’ technology and capital to OPEC’s underexploited resources. That could result in alliances, too, but they might look a bit different than the proposed ExxonAramco. On the other hand, an OPEC country, flush with cash generated by sustained $45 oil, might find one of these companies an attractive acquisition target. That has also happened before.

Tuesday, August 17, 2004

The Meaning of "No"
President Hugo Chavez may find much to relate to in Nietzsche's remark, "That which does not destroy me makes me stronger." Despite some expressions of concern about voting irregularities, the Carter Center and other international observers have endorsed the "no" outcome of Sunday's referendum on Chavez's rule. As I suggested last week, this may reduce one kind of political risk for oil investors, but it will surely create new ones.

Last Friday's NY Times carried this article describing Chavez's plans for an integrated energy network in South America. In itself, this may be a good idea that would promote broader economic development throughout the continent, even as it increased Mr. Chavez's political leverage and influence. But the plan also reflects a desire to reorient Venezuela's oil marketing efforts away from its reliance on the US market. While that may be good politics in Latin America, it poses big challenges for North America.

The great energy success story in the wake of the oil crises of the 1970s was the diversification of US energy imports away from the Middle East, and Venezuela played a key role in that. Along the way PDVSA, the Venezuelan state oil company, acquired a US refining and marketing company, CITGO, and international oil companies made significant investments in Venezuelan oil projects. Barring a new international crisis, it wouldn't make sense for Venezuela to cut off its oil shipments to this country, but even a gradual move away from the US and towards new partners in Latin America would leave a void.

With domestic production continuing to decline and West Africa, the other big success story of the 1980s and 90s, suffering from crippling unrest and corruption, the likely outcome of such a shift is either growing US reliance on Middle East oil, or a more intense effort to strengthen energy ties with Russia, which has significant untapped potential. If so, the results of Sunday's election will reverberate around the globe for years to come.

By the way, tomorrow is a travel day for me, so there won't be a new blog. Postings will resume on Thursday.

Monday, August 16, 2004

One Year Later
I'll never forgot the date of the Northeast blackout of 2003, because my daughter was born in the middle of it. However, I have to wonder if others' memories are shorter, particularly those of the legislators, regulators, and utilities that all seemed so gung ho to rectify the problems that led to the largest power disruption in the country's history. That view is corroborated by articles such as this one in the Financial Times.

It's relatively easy to imagine a future power grid that is much more resistant to outages such as last year's. It could be the intelligent grid that some have likened to the Internet, with widespread two-way metering and seamless integration of a myriad of small generators, enabled by high speed computing. It might just be a more robust version of today's grid, with extra capacity added to key choke points and a larger generating surplus, or a mixture of the two. The hard part is actually getting there from where we are now.

Doing so will require greatly reduced uncertainty about the future regulatory framework, along with the prospect of returns that are attractive enough to lure capital away from other investment opportunities. That means Congress needs to enact an energy bill to replace the one that has been stalled for the last year, despite broad consensus that better energy policy is urgently required. It also means that local regulators must make electrical reliability a higher priority and create incentives for the grid operators and utilities to upgrade their systems.

That can only happen with strong public support and a willingness to set aside parochial concerns such as the interstate rivalry that bedeviled the new connector between Long Island and Connecticut, as well as a better process for addressing local concerns about infrastructure projects, rather than the current labyrinth of legal challenges that most such projects now face.

When you consider all the necessary preconditions, it's no wonder that little progress has been made since last August. This summer nature has been kind, with milder temperatures in the Northeast. But the combination of economic growth, which will drive up power demand, with more typical weather patterns will surely test the system again.

Friday, August 13, 2004

Backwardation
It's generally agreed that the current high oil prices are the result of an accumulation of factors, none of which by itself would be sufficient to drive prices up very far, or for very long. When combined, however, they have taken us to sustained record nominal prices and real prices that are high enough to constitute a significant drag on the global economy. This thoughtful article in today's New York Times reminds us that, while this is true, the magnitude of the outcome is also a function of decades of underinvestment in infrastructure that erased the former surplus capacity, which acted as the buffer against such glitches.

The article also touches on the role that the market feature called "backwardation" has played in this drama. Backwardation is a condition of commodities markets in which the price of the commodity falls off into the future months, the further you get from the nearest, or "prompt" month being traded. In equilibrium, the level of backwardation, that is, the difference in prices between successive months, should be just enough to cover the cost of holding the commodity in storage for a month, plus time value of money.

In practice, that difference varies a good deal, and is the subject of much speculative trading, as players bet on its widening or narrowing. Sometimes the difference goes negative, producing "contango", the opposite of backwardation.

But when you get beyond a year or two in the future, the shape of the futures market curve should flatten, because the alternate supply is not oil in a tank, but oil in the ground, the carrying costs of which are very low. This is at the heart of Mr. Norris's argument. When today's price for the commodity several years from now is very much lower than the price for current delivery, because the market believes that prices will fall back after the current crisis is resolved, it sends a negative signal to producers: investing to get more oil out of the ground will not yield an attractive return. This same feature has played Hobb with the value of oil company equities, which haven't benefited nearly as much as they should have from the runup in oil and gas prices in the last year. That's yet another negative signal for investors.

The good news is that the future price is rising, even though it is still well below the prompt price, signaling a belief that today's problems may persist for a while. That should finally result in an uptick in capital spending, which is the only way that world oil production is going to keep pace with the growth in demand; it has to look like an attractive proposition for investors.

Thursday, August 12, 2004

Nuclear Waste
Yesterday I ran across this press release from the Kerry campaign, concerning storage of nuclear waste at the designated federal waste site at Yucca Mountain, Nevada. It certainly raises some very serious concerns about this location and about the storage of nuclear waste, in general. However, there are some logical questions that we should be asking about some of these objections, such as:

- Will it be possible to find any storage site so remote that no population is ever at risk, should the storage eventually leak? The fact that Yucca Mountain is within the government's nuclear weapon test site suggests to me that it is probably about as unpopulated as one could find anywhere these days. The alternative would probably be so remote that it would draw criticism for the damage that new infrastructure would do to pristine ecosystems.

- Is it possible to locate any site that is truly seismically inert? A little knowledge of plate tectonics and the geology of the continent suggests that could be a very high hurdle. Instead, we should be asking whether any of the six faults identified near the Yucca site has a history of generating earthquakes large enough to threaten the proposed containment systems.

- Can any disposal method avoid road or rail transportation of nuclear waste and radioactive material from the 100+ currently operating and decomissioned nuclear plants around the country, and from other industrial sources of radioactive waste? Whether the waste goes to Nevada or to the moon it has to travel there somehow. This criticism is not really specific to the Yucca Mountain project, but rather reflects an aspect of any long-term solution to nuclear waste that must be scrutinized carefully.

At the end of the day, it could be that Yucca Mountain isn't the right spot to bury the accumulated waste of sixty years of commercial nuclear power and nuclear weapons production. And with the current threat of terrorism, maybe we need to sharpen our pencils a bit more on how we'd move waste from where it was generated to where it will be buried. But I have to admit to a large degree of skepticism about a laundry list of more-or-less relevant concerns about a proposed waste site in a critical "swing state", released during a political campaign.

We still need to be able to store or otherwise neutralize nuclear waste with a high level of security and integrity for a minimum of several thousand years, based on the half-lives of its most dangerous components. That's no mean undertaking, and the choice of how and where to do this should be made with great care and deliberation. But is it realistic to think that, after at least two decades of working on this problem, we are ever going to find a disposal option that does not meet with opposition from some local community and/or group of well-intentioned experts? With all due respect to the citizens and voters of Nevada, if not there, then where?

We also need to keep firmly in mind that every day we generate additional tons of waste, and that in most cases the present storage location for that waste is a much poorer choice from both a security and integrity perspective than any long-term storage site we could contemplate. Is this a classic case of the perfect getting in the way of the good?

Wednesday, August 11, 2004

Fuels for Wartime
With so much attention focused on the attractiveness of alternative fuels for industry and consumers, the energy needs of the military are easy to ignore. But with increasingly sophisticated combat hardware deployed in multiple theaters of war, this is an issue in which the Pentagon is keenly interested. As this article on possible battlefield applications of gas-to-liquids technology indicates, it is also an area with no shortage of R&D money.

As we have seen in Iraq, the high fuel consumption of modern tanks, infantry fighting vehicles, and attack and transport helicopters requires a large, expensive and vulnerable fuel supply chain. The military and its civilian partners are pursuing both the application of advanced technology to reduce fuel consumption, including hybridization and fuel cells, as well as efforts such as the Syntroleum approach to produce fuel closer to where it is needed.

While it is possible that one or the other avenue will produce useful spinoffs for domestic applications, the history of military procurement cycles suggests that it is equally likely that technology will flow in the opposite direction.

Nevertheless, military applications of advanced vehicle technology and alternative fuels represent an important early market for both. Because the cost of fuel delivered to the battlefield is so much higher than for any other application you can think of, short of spaceflight, this market will be less price-sensitive and more focused on performance. This could give developers a chance to move down the experience curve with fewer of the usual commercial pressures, and that might mean a greater variety of viable alternatives showing up in the marketplace in a few years. Ultimately, that could be very positive for improving energy security and possibly even lowering energy costs.

Tuesday, August 10, 2004

Betting on Hugo
The long-anticipated Venezuelan referendum on the rule of Hugo Chavez will take place this Sunday. Despite Mr. Chavez's anti-US rhetoric, the energy industry appears to be betting on his winning a reprieve, as this article from the Financial Times notes. This puts them in the uncomfortable position of favoring someone who will most likely end up as a classic South American Generalissimo/President-for-Life, even if he got there democratically. It all comes down to risk management.

As the FT points out, the goal for companies with billions of dollars of past investments at risk, and billions in future opportunities at stake, is political stability, regardless of its flavor. In this case, I suggest that this attitude is not merely cynical, but ill-advised. Whatever positive remarks Mr. Chavez may have made concerning his commitment to continue supplying oil to the US, his current policies set him on a collision course with US diplomacy, and possibly even the War on Terrorism, in the future.

Venezuela needs the energy companies at least as much as they need its resources. In the wake of the massive oil industry strike in 2002 and the subsequent draconian restructuring of the state oil company, PDVSA, the country requires foreign technical expertise to keep its oil flowing. This is not the Middle East, where you drill a hole and watch the oil happily flow out for decades. The bulk of Venezuelan petroleum is heavy, and, as such, it takes much more ongoing maintenance and management to keep production going, as demonstrated by the unreported quantity of pre-strike output that is still offline.

The Chavistas also need capital investment from the international energy companies. With the lion's share of oil revenues committed to social programs--which coincidentally greatly bolster Mr. Chavez's support at the polls--rather than being reinvested, oil production will eventually grind to a halt without steady infusions of foreign money. I'm sure the companies are reassured by this dependency.

But I wouldn't bet that a confrontation won't originate on our side, particularly if the Bush administration is reelected. A Venezuela that supports the Colombian rebels and cozies up to Cuba is probably only a few steps away from an "Axis of Evil" designation. Instability comes in many varieties, and anyone considering new investments in Venezuela should bear that in mind.

Monday, August 09, 2004

Have We Really Forgotten?
Returning from a week's vacation, I see that concerns about high oil prices remain staples for both the media and politicians. Today's Wall St. Journal included articles on oil's impact on the economy, and on the presidential candidates' positions on energy policy. But it strikes me as odd that we haven't heard anyone--so far as I've noticed--point out the blindingly obvious but genuinely noteworthy fact that current high oil prices are actually a strong signal that the markets are working, doing their job as intended and doing it well.

The last time we had sustained oil prices at this level in nominal terms--though not in real dollars--our worries were more immediate than a possible slowdown in economic growth. We had gas lines, gas rationing of a sort (odd-even license plate restrictions), and bizarre wholesale- and producer-level activity that actually reduced efficiency and held up supplies. All of this was the result of non-market based policy responses to an "energy crisis." As tempting as it might be to fiddle with things now in an attempt to push down energy prices in the short run, we should remember that there are worse outcomes than buying the energy we need at high prices.

Any meaningful long-term changes in our energy situation will require years to implement and still longer to take effect. That doesn't mean such changes aren't worth undertaking--quite the contrary--but the debate about them shouldn't be colored by short-term concerns, which are driven at least in part by short-term problems (Yukos, Nigeria, etc.,) and for which only smoothly-functioning energy markets can compensate.

It is also worth recognzing that those most affected by high oil prices are not consumers in the developed countries, such as the US, but the billions in the developing world living on a dollar or two a day. High oil prices represent a serious drain on hard currency for their nations, many of which have little alternative but increased external borrowing.

Monday, August 02, 2004

Blog on Vacation
There won't be any new postings to this blog until next Monday, August 9. Before signing off the for the week, I'll provide links to some past blogs that seem particularly timely, again.

I'm also thinking about pertinent topics to write on in the weeks ahead, beyond what is suggested by my reading of the news. One area I've wanted to discuss for a while is the more conventional forms of alternative energy, such as tar sands (now usually referred to as oil sands), ultra-heavy oil, and shale, along with coal liquefaction and gasification. But I'm also interested in hearing from you concering subjects of interest. You can provide this feedback either by clicking on the "comments" link below this posting, or by email mailto:gsws@optonline.net.

Now for the links to "classic postings" (you'll have to scroll down in the linked monthly archive to the date indicated):